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Ruling

Subject: Rental property expenses

Question

Are you entitled to a deduction for your share of the loan interest, rates and other holding costs incurred to construct a property for future income producing purposes?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

Approximately a year ago you jointly purchased land with your spouse on which you will build a rental property.

You have jointly borrowed part of the funds needed to purchase the land and have sought advice from a tax agent.

You have had the draft schematic design done for a single dwelling, and you hope to have the final plans completed shortly. Your architect initially misinterpreted your concept, and is now constructing a three dimensional model.

When this is done, you will have a quantity surveyor cost the building out. You have conducted considerable research into the market and as part of the planning process are taking into account the best yield for the type of building/s you put on the land.

You have an outside estimate of three years in which the property will be income producing. If construction is commenced during 2012, you are confident it would be completed within a 12 month period, and have taken into account the rate of new building construction in your state at present.

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) states that a deduction is allowable for expenses incurred in gaining or producing assessable income, provided those expenses are not capital, private or domestic in nature.

Interest on funds used to purchase a property on which the taxpayer intends to build an income-producing asset may be deductible, with land tax and other holding costs, from the time of the acquisition of the property (Steele v. FC of T (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 [Steele's case]) under section 8-1 of the ITAA 1997. It is not necessary to show that the expense was incurred in producing income of a particular year. Expenses that are otherwise deductible are not excluded from deductibility simply because no assessable income was derived in the relevant year.

The Commissioner limits the operation of Steele's case to circumstances where:

· the expense is not preliminary to the income-earning activities. In other words, it is not incurred too soon

· the expense is not of a private or domestic nature

· the period prior to the derivation of income is not so long that the required connection between the outgoings and income is lost

· the expense is incurred with one end in view, namely the gaining or producing of assessable income, and

· continuing efforts are undertaken in pursuit of that end. While this does not require constant on-site development activity, the requirement is not satisfied if the venture becomes truly dormant and the holding of the asset is passive, even if there is an intention to revive the venture at some time in the future (Taxation Ruling TR 2004/4).

In your case, the expenses were incurred in relation to land on which you will construct an investment property.

Your intention is to use the property for income producing purposes once it is completed. In your circumstances it is considered that the expenses were not incurred at a point 'too soon', and were not preliminary to the commencement of the income earning activity.  The length of time between purchase of the property, anticipated commencement of construction and completion is not considered to be so long that the necessary connection between the outgoings and the assessable income is lost.

Accordingly, you are entitled to your share of a deduction under section 8-1 of the ITAA 1997 for expenses such as loan interest, land tax and other holding costs incurred in relation to the purchase of the property.

Division of net income or losses between co-owners of rental properties

Taxation Ruling TR 93/32 Income tax: rental property - division of net income or loss between co-owners refers to the division of net income or loss between joint owners of a rental property.

According to TR 93/32, the income/loss from the rental property must be shared according to the legal interest of the owners except in those very limited circumstances where there is sufficient evidence to establish that the equitable interest is different from the legal title.

The equitable interest will only be different if one of the owners shown on the title deed is holding their share of the property in trust for the other party.

Co-ownership

Co-owners of a rental property will generally hold the property as joint tenants or tenants in common. An important feature of both a joint tenancy and a tenancy in common is the legal interest of the tenant. It is this legal interest which ultimately determines among co-owners of property, the division of the net income or loss from the property.

Co-owners of a property who are joint tenants of that property will hold identical legal interests in the property. That is, their interest must be the same in extent, nature and duration - each owns an identical 50% share in a property.

Paragraphs 48 and 49 of TR 93/32 provide the following example:

Mr and Mrs Z rent out a house that they own as joint tenants. The rent is paid into a joint account from which expenses of the property are paid. The expenses of the property exceed the rental income from it each year. Mr Z claims that as he is the sole income earner and had in effect paid all the expenses, he is entitled to claim 100% of the loss.

Owning and renting out the one property does not amount to carrying on a business. Mr and Mrs Z are not partners at general law although their relationship is treated as a partnership for income tax purposes. Net profits and losses from the property should be shared in the same proportion as their ownership interests, that is 50:50. The fact that Mr Z has paid all the expenses on the property is of no consequence for income tax purposes. We would simply treat the payment of Mrs Z's share of the expenses by Mr Z as no more than a loan by Mr Z to Mrs Z.

Consequently the income and expenses of the property must be split equally between you and your spouse, the joint owners.